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Sudden Stops, Financial Crises and Leverage: A Fisherian Deflation of Tobin's Q

  • Enrique G. Mendoza

This paper shows that the quantitative predictions of a DSGE model with an endogenous collateral constraint are consistent with key features of the emerging markets' Sudden Stops. Business cycle dynamics produce periods of expansion during which the ratio of debt to asset values raises enough to trigger the constraint. This sets in motion a deflation of Tobin's Q driven by Irving Fisher's debt-deflation mechanism, which causes a spiraling decline in credit access and in the price and quantity of collateral assets. Output and factor allocations decline because the collateral constraint limits access to working capital financing. This credit constraint induces significant amplification and asymmetry in the responses of macro-aggregates to shocks. Because of precautionary saving, Sudden Stops are low probability events nested within normal cycles in the long run.

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File URL: http://www.nber.org/papers/w14444.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 14444.

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Date of creation: Oct 2008
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Publication status: published as Enrique G Mendoza, 2010. "Sudden Stops, Financial Crises, and Leverage," American Economic Review, vol 100(5), pages 1941-1966.
Handle: RePEc:nbr:nberwo:14444
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  1. Pablo Neumeyer & Fabrizio Perri, 2004. "Business cycles in emerging economies: the role of interest rates," Staff Report 335, Federal Reserve Bank of Minneapolis.
  2. Philip Lane & Gian Maria Milesi-Ferretti, 2001. "THE EXTERNAL WEALTH OF NATIONS: Measures of Foreign Assets and Liabilities For Industrial and Developing Countries," Trinity Economics Papers 20014, Trinity College Dublin, Department of Economics.
  3. Helene Rey & Philippe Martin, 2005. "Globalization and Emerging Markets: With or Without Crash?," 2005 Meeting Papers 152, Society for Economic Dynamics.
  4. Ceyhun Bora Durdu & Enrique G. Mendoza & Marco E. Terrones, 2007. "Precautionary demand for foreign assets in sudden stop economies: an assessment of the new mercantilism," International Finance Discussion Papers 911, Board of Governors of the Federal Reserve System (U.S.).
  5. Cook, David & Devereux, Michael B., 2006. "Accounting for the East Asian Crisis: A Quantitative Model of Capital Outflows in Small Open Economies," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 38(3), pages 721-749, April.
  6. Guillermo A. Calvo & Alejandro Izquierdo & Ernesto Talvi, 2006. "Phoenix Miracles in Emerging Markets: Recovering without Credit from Systemic Financial Crises," NBER Working Papers 12101, National Bureau of Economic Research, Inc.
  7. Mendoza, Enrique G, 1991. "Real Business Cycles in a Small Open Economy," American Economic Review, American Economic Association, vol. 81(4), pages 797-818, September.
  8. David Cook & Woon Gyu Choi, 2002. "Liability Dollarization and the Bank Balance Sheet Channel," IMF Working Papers 02/141, International Monetary Fund.
  9. Mendoza, Enrique G. & Smith, Katherine A., 2006. "Quantitative implications of a debt-deflation theory of Sudden Stops and asset prices," Journal of International Economics, Elsevier, vol. 70(1), pages 82-114, September.
  10. Calvo, Guillermo A. & Izquierdo, Alejandro & Loo-Kung, Rudy, 2006. "Relative price volatility under Sudden Stops: The relevance of balance sheet effects," Journal of International Economics, Elsevier, vol. 69(1), pages 231-254, June.
  11. Gopinath, Gita, 2003. "Lending Booms, Sharp Reversals and Real Exchange Rate Dynamics," Scholarly Articles 11988005, Harvard University Department of Economics.
  12. Roberto Garcia-Saltos & Leonardo Auernheimer, 2000. "International Debt and the Price of Domestic Assets," IMF Working Papers 00/177, International Monetary Fund.
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  14. Guillermo A. Calvo, 1998. "Capital Flows and Capital-Market Crises: The Simple Economics of Sudden Stops," Journal of Applied Economics, Universidad del CEMA, vol. 1, pages 35-54, November.
  15. Enrique G. Mendoza & Vivian Z. Yue, 2008. "A Solution to the Disconnect between Country Risk and Business Cycle Theories," NBER Working Papers 13861, National Bureau of Economic Research, Inc.
  16. Cook, David & Devereux, Michael B., 2006. "External currency pricing and the East Asian crisis," Journal of International Economics, Elsevier, vol. 69(1), pages 37-63, June.
  17. Javier García-Cicco & Roberto Pancrazi & Martín Uribe, 2006. "Real Business Cycles in Emerging Countries?," NBER Working Papers 12629, National Bureau of Economic Research, Inc.
  18. Epstein, Larry G., 1983. "Stationary cardinal utility and optimal growth under uncertainty," Journal of Economic Theory, Elsevier, vol. 31(1), pages 133-152, October.
  19. Rodrigo García Verdú, 2005. "Factor Shares From Household Survey Data," Working Papers 2005-05, Banco de México.
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